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The Intelligent Investor Portfolio – American Version (USD) – presents an impressive 13,60% return (taxes and broker commissions not included) since inception (10th March 2017), standard deviation of 17,06% and a sharpe ratio of 0,8421.

The Intelligent Investor Portfolio – European Version (EUR) – presents an impressive 28,22% return (taxes and broker commissions not included) since inception (29th February 2016), standard deviation of 18,00% and a sharpe ratio of 0,7341.

The overall strategy is simple, I search for the market’s return, using Exchange traded funds (ETF’s) that replicate market index (like the S&P 500). It is my believe that, in average, an in-depth research will is only useful if you are investing billions, otherwise you will spend much more on research than you receive extra from the market. Since an Index is already diversified by sectors & industries, I also look for ETF’s from other regions to diversify my portfolio more.

Portfolio inception date is March 10th 2017 and I use a passive management strategy (Buy and hold), applying the modern portfolio theory (mean-variance analysis) to achieve the proportion-weighted combination of the constituent asset’s.

Portfolio is rebalanced once a year, with dividends reinvested.

Since inception until December 29th 2017, the Intelligent Investor Portfolio presents a 13,60% return (excludes taxes and commissions and includes dividends).

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Being an international investor with a well diversified portfolio, you should be aware of interest rate variations.

Before you analyze the effects in your portfolio, it is important to understand who changes the reference interest rates and why.

The interest rate, as one of the instruments of the monetary policy, may be amended by the central banks. I am talking about the FED and ECB and other bank regulators.

An increase of the interest rate suggests a contractionary policy, and a reduction of the interest rate suggests an expansionary policy.

But the initial question remains to answer, what happens to my portfolio?

To answer that question we will have to analyze the question from various perspectives:

-What’s the new return required by the investor to invest in a particular stock (risk premium)?

One of the ways used to calculate the required return for a stock is the CAPM method.

A change in the reference interest rate will produce a change in the investor’s required return.

When we change the value of the expected income, a rational investor will evaluate if the market presents other investments, more attractive and profitable. It can also motivate a change in the portfolio’s proportion between stocks and bonds.

What’s the effect on bond’s investments?

For an investor who already holds a bond investment, and knowing that the price equals the sum of all cash flows discounted at a given rate (yield to maturity), a change in the reference rate will also change the discount rate and affect the bond’s price. Therefore, a rise in interest rates will cause the bond price to go down and vice versa.

However, if the investor holds the bond until maturity, the bond’s price will be 100% (called a “pull to par” effect).

-What is the currency effect when reference interest rate changes?

Having foreign investment, a change in the reference interest rate will affect the value of the quotation, as for example, EUR/USD par, and have positive or negative effects on your investments.

The income of a foreign financial asset can be calculated using the following formula (1 + asset Income) * (1 + currency Income) -1.

According to the international Fisher effect (and keeping everything else constant) if interest rates changes 1%, exchange rates will vary the same amount but in reverse. In other words, if I am an European investor and have an USD investment, when the American interest rate rises, the dollar will appreciate against the euro, having a positive effect in my portfolio.

You can now understand that a change in the interest rate will have an effect on your portfolio and it requires monitoring.

I also present you with my own portfolio model that you can access here.

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In my previous post, I mention I would make available a portfolio model, for information purpose (not investment advice).

I will assume that you have read my “10 rules before investing” post and that you are ready to invest long term.

I called this model the “Intelligent Investor Portfolio – European version”, and I refer as European because the domestic currency is EUR.

Currency is relevant because you must consider it in your portfolio asset, estimate it’s return and the overall standard deviation with foreign currency before you apply the modern portfolio theory (mean-variance analysis) to achieve the proportion-weighted combination of the constituent asset’s.

Inception date is February 29th 2016 and I use a passive management strategy (Buy and hold). Portfolio is rebalanced once a year, with dividends reinvested.

I use ACWI ETF as my benchmark proxy, which is an ETF that seeks to track the investment results of an index composed of large and mid-capitalization developed and emerging market equities.

Since inception, Intelligent Investor Portfolio presents a 28,22% return (excludes taxes and commissions and includes dividends) and a standard deviation of 18,00%.

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In my last post, I wrote about the investment basics and what to do before investing in the stock market.

Now you must select the stocks you intend to invest, to make a well diversified portfolio, minimizing the risk and maximizing your return.

No matter if your strategy is trading or investing long term, you will always need to select your stocks to invest in (or trade).

And there is no way for an inestor to avoid a market research, you must study the companies publicly traded well and look at the financial ratios. They can help you invest wisely and making much more money!

When you are investing in the stock market, you should look at companies financial strength ratios, profitability ratios and valuation ratios.

Some strength ratios:

Current Ratio: creditors often compare a firm’s current assets and current liabilities to assess whether the firm has sufficient working capital to meet its short-term needs

Current Ratio = Current Assets / Current Liabilities

Debt-Equity Ratio: used to assess a firm’s leverage

Debt-Equity Ratio = Total Debt / Total Equity

Interest Coverage Ratio: assess a firm’s ability to meet its interest obligations by comparing its earnings with its interest expenses

Interest Coverage Ratio = EBIT / Interest Expense

Some profitability ratios:

Operating Margin: reveals how much a company earns before interest and taxes from each dollar of sales

Operating Margin = Operating Income / Sales

Net Profit Margin: shows the fraction of each dollar in revenues that is available to equity holders after the firm pays interest and taxes

Net Profit Margin = Net Income / Sales

Return on Equity: provides a measure of the return that the firm has earned on its past investments

Return on Equity = Net Income / Book Value of Equity

Valuation Ratios (use it to compare with competition and industry)

Price-Earnings Ratio: measure that is used to assess whether a stock is over- or undervalued based

I recommend you learn more about it. A good book that explains in depth all these financial ratios and much more, and for sure will help you know more about how to invest in the stock market is Corporate Finance (3rd Edition) (Pearson Series in Finance), a must read for an intelligent investor.

If you wish to compare your financial ratios with competitors and the industry, you have available a lot of free information like Damodaran, yahoo finance, google finance and so on.